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Pay for Performance and Financial Incentives3Copyright 2013 Pearson EducationChapter 12-1

There is tension between the concept of providing employees with a secure, stable income, and the idea of linking pay directly to performance. Some feel pay for performance allows employeesthe ability to be entrepreneurial and take appropriate risks for the company. Improved employee performance must be linked to improved organizational performance if incentive pay is to be more than just another labor cost.

For this chapter we will take an overview of money and motivation, then outline different incentive programs used for different types of employees. We also will discuss organization-wide incentive plans.

1Learning ObjectivesExplain how you would apply five motivation theories in formulating an incentive plan.Discuss the main incentives for individual employees.Discuss the pros and cons of commissions versus straight pay incentives for salespeople.Copyright 2013 Pearson EducationChapter 12-22Learning ObjectivesDescribe the main incentives for managers and executives.Name and define the most popular organization-wide variable pay plans.Outline the steps in designing effective incentive plans.Copyright 2013 Pearson EducationChapter 12-33Money and MotivationCopyright 2013 Pearson EducationChapter 12-4Frederick Taylor was an American mechanical engineer who sought to improve industrial efficiencies. He made three major contributions in the late 1800s. First he defined a fairs day work using standards of output. Second, he is known as the father of the scientific management approach. This approach emphasized improvement of work methods. Finally, he recognized the use of financial incentives for those whose output exceeded standards.

Today, business is characterized by consideration of compensation, shareholder value, and turbulence. The three factors have produced a renaissance for financial incentive/pay-for-performance plans.

4Explain how you would apply five motivation theories in formulating an incentive plan.Copyright 2013 Pearson EducationChapter 12-55

Motivation and IncentivesMaslows Hierarchy of NeedsCopyright 2013 Pearson EducationChapter 12-6The law of individual differences means that people differ in personality, abilities, values, and needs. Individuals, therefore, react to different incentives in different ways. Several theorists have contributed information relevantto designing incentive plans. Lets discuss each of them.

The Hierarchy of Needs and Abraham Maslow This hierarchy includes five types of needs: physiological, security, social (love and belongingness), self-esteem, and self-actualization. According to Maslow, people are motivated to satisfy lower-order needs first and then work their way up the hierarchy in sequence,6Motivation and IncentivesHerzbergs Two-Factory TheoryDeci and demotivatorsCopyright 2013 Pearson EducationChapter 12-7Motivators and Frederick Herzberg Hygiene-motivator theory divides needs into two factors. Hygiene factors include such things as working conditions, salary, and incentives. Motivators include those factors that make the job more intrinsically motivating, like challenge, feedback, and recognition. He further claimed that the absence of hygiene factors would not foster a motivated individual. However, once hygiene factors had been attended to, the presence of motivator factors would create a motivated employee.

Edward Deci found that extrinsic rewards could, at times, actually detract from an employee who already possesses a great deal of intrinsic motivation.

7Motivation and IncentivesExpectancy Theory, Victor VroomCopyright 2013 Pearson EducationChapter 12-8

Expectancy theory suggests that a persons motivation to exert some level of effort is a function of three things. First is the persons expectancy (in terms of probability) that his or her effort will lead to performance. Second is theinstrumentality, or the individual's perceived connection (if any) between successful performance and actually obtaining the rewards. Third,valence, represents the perceived value the person attaches to the reward.

8Motivation and IncentivesBehavior modificationIncentive pay terminologyEmployee incentives and the lawCopyright 2013 Pearson EducationChapter 12-9Behavior Modification/Reinforcement and B. F. Skinner Psychologist B.F. Skinner proposed that to understand behavior, one must understand the consequences of that behavior. Behavior modification means changing behavior through rewards or punishments that are contingent upon performance.

Traditionally, allincentive plans are pay-for-performance plans. Variable pay is usually an incentive plan that ties pay to some measure of the firms overall profitability. However, confusing as it may be, some experts have usedthe term variable pay to include incentive plans for individual employees.

The employer must comply with the overtime provisions of the Fair Labor Standards Act (FLSA) when designing and administering its incentive plans. Certain bonuses are excludable from overtime pay calculations. However,many other types of incentive pay must be included.

9ReviewMoney and motivationMotivation theoriesIncentivesTerminologyThe law

Copyright 2013 Pearson EducationChapter 12-10For this learning objective, we have discussed the relationship between money and motivation. In addition, we covered various theories of motivation including:Maslows Hierarchy of NeedsHerzbergs Two-Factor TheoryDemotivatorsExpectancy TheoryBehavior modification

Finally, we touched on the terminology used for incentive pay and the relationship of employee incentives to the law.

Lets now turn our attention to the main incentives for individual employees. 10Discuss the main incentives for individual employees.Copyright 2013 Pearson EducationChapter 12-11Several incentive plans are particularly suited for use with individual employees. 11Individual Employee Incentive and Recognition ProgramsMerit pay as an incentiveDifferential pay increasesMerit pay options

Copyright 2013 Pearson EducationChapter 12-12Piecework plansStraight pieceworkStandard hour plansPros and cons

Piecework is the oldest and still most popular individual incentive plan. Piecework involves paying the worker aspecified amount for each piece or unit he/she produces. Straight piecework entails a strict proportionality between results and rewards regardless of output. With a standard hour plan, the worker gets a premium equal to the percent by which his/her performance exceeds the standard.

The pluses for piecework are that piecework plans are understandable, appear equitable, and can be powerful incentives, since rewards are proportionate to performance. On the other hand, workers may resist even justified attempts to raise production standards. This may occur in part because a cultural norm has been established between the employees performing the same work. Occasionally, employees may well downplay quality, or resist switching from job to job (since doing so could reduce productivity). Attempts to introduce new technology or processes may trigger resistance, for much the same reason.

Merit pay or a merit raise is any salary increase the firm awards to an employee based on his/her individual performance. Merit plan effectiveness depends on trulydifferentiating among employees.

Two adaptations of merit pay plans are popular. One awards merit raises in a lump sum once a year and does not make the raise part of the employees salary. The other adaptation ties merit awards to both individual and organizational performance.

12Individual Employee Incentive and Recognition ProgramsIncentives for professional employeesNonfinancial and recognition-based awardsIncentives managers can useOnline and IT-supported awardsJob designCopyright 2013 Pearson EducationChapter 12-13Professional employees are those whose work involves the application of learned knowledge to the solution of the employers problems, such as lawyers, doctors, economists, and engineers.

Recognition programs usually refer to formal programs such as employee-of-the-month programs. Social recognition programs are more informal manager-employee exchanges, including praise and approval. First, the best option for motivating employees is also the simplestmake sure the employee has a doable goal with which he or she agrees. Second, simply recognizing an employees contribution is a powerful motivation tool. Third, the manger can use casual social recognition as positivereinforcement on a day-to-day basis.

There are many reasons to use Internet sites and IT to manage awards programs. The sites can offer a much broader range of products than most employers could catalog and offer by themselves. And perhaps most importantly, the whole process is expedited, so its much easier to bestow and deliver the awards.

Research has shown that job design, job responsibility, and feedback from a job are primary drivers of employee engagement.13ReviewPieceworkMerit payIncentives for professionalsNonfinancial rewardsOnlineJob designCopyright 2013 Pearson EducationChapter 12-14For this learning objective, we have discussed the two types of piecework plans and their pros and cons. In addition, we noted that merit pay requires truly differentiating between employees, which is difficult for some managers due either to a lack of effective recordkeeping or reluctance to distinguish between employees.

Professionals require different non-financial incentives such as time off for participation in professional organizations. Computer-based management of incentive and recognition programs offer several advantages compared to traditional approaches, including more timely distribution of rewards and tracking.

Finally, job design, responsibility and feedback are important to many employees at all levels. 14ThePros and Cons of Commissions vs. Straight Pay Incentives for SalespeopleCopyright 2013 Pearson EducationChapter 12-1515Incentives for SalespeopleSalary planCommission planCombination planMaximizing sales force resultsHow effective are your incentives?Copyright 2013 Pearson EducationChapter 12-16Fixed salaries are offered by some firms. Straight salary makes it simple to switch territories or to reassign salespeople, and it can foster loyalty. A disadvantage is that it can constrict sales and de-motivate potentially high-performing salespeople.

Salespeople are paid for results, and only for results. Thus, commission plans tend to attract high-performing salespeople who see that effort clearly leads to rewards. But it may cause them to neglect non-selling duties like servicing small accounts, cultivating dedicated customers, and pushing hard-to-sell items.

Most companies pay salespeople a combination of salary and commissions, usually with a sizable salary component. Combination plans give salespeople a floor to their earnings and still provide an incentive for superior performance.

Setting effective quotas is an art. In todays fast-changing business scene, sales quotas must become more flexible than they have been in the past. There is a tendency to set commission rates informally, without considering how much each sale must contribute to coveringexpenses.

To maximize performance, the sales manager typically needs evidence. Answering the following questions will provide such information.Do the sales team members understand the compensation plans? Do they know how we measure and reward performance? Are quotas set fairly? Is there a positive correlation between performance and commission earnings? Are commissions more than covering total salespersons expenses? Does our commission plan maximize sales of our most profitable products?

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ReviewTypes of sales incentivesMaximizing resultsEffectivenessCopyright 2013 Pearson EducationChapter 12-17For this learning objective, we have discussed some of the pros and cons between straight salary plans and commission plans. We also noted that most companies offer a combined program, with a substantial emphasis on salary.

To maximize results, we recommended you use formal and systematic methods of setting sales quotas. Finally, to determine how effective your incentive program is, a number of questions must be answered. Some have to do with the level of understanding of your program by your salesforce. Others have to do with measuring the correlations between your program and the results produced17Describe the main incentives for managers and executives.Copyright 2013 Pearson EducationChapter 12-1818Incentives for Managers and ExecutivesStrategy and the executives long-term and total rewards packageSarbanes-Oxley ActShort-term incentives, annual bonusEligibilityFund sizeIndividual performanceFormulaCopyright 2013 Pearson EducationChapter 12-19Few HR practices have as profound or obvious an impact on strategic success as the companys long-term incentives. In creating the compensation package, you should: consider the strategic context; shape each component of the package,then group them; create a plan that gives the package a special character;check for legal compliance and tax effectiveness; and install a review and evaluation process for major business changes.

The Sarbanes-Oxley Act affects how employers formulate their executive incentive programs. It also injects a higher level of responsibility into executives and board members decisions.

For short-term incentives, the annual bonus is aimed at motivating the short-term performance of managers and executives. Eligibility usually includes both top and lower-level managers.

Fund size refers to the total amount of bonus money the firm makes available. A target bonus and maximum amount is set for each eligible position, and the actual award reflects the persons performance. Finally, a formula may be used to base the bonus on specific measures critical to the company.

19Incentives for Managers and ExecutivesStrategic long-term incentivesStock optionsStock option problemsOther stock plansEthics and incentivesOther executive incentivesCopyright 2013 Pearson EducationChapter 12-20Strategic long-term incentives are used to inject a long-term perspective into executives decisions.

Stock options account for over half of executives compensation. A stock option is the right to purchase a specific number of shares of company stock at a specific price during a specific period of time. Stock options can reward managers who experience a less than stellar performance. They also can encourage executives to take riskier ventures to increase profits.

Other stock plans include stock appreciation rights, a performance achievement plan and a restricted stock plan.

Stock appreciation rights permit the recipient to exercise the stock option (by buying the stock) or to take any appreciation in the stock price.

A performance achievement plan awards shares of stock for the achievement of predetermined financial targets.

In a restricted stock plan, shares are usually awarded without cost to the executive, but selling the stock is restricted for a specified time period.

Simplistic, financial-performance-oriented incentives, in the absence of strong ethical standards may breed unethical behavior. The solution is to foster a forward-looking ethical culture.

Companies provide various other incentives to persuade executives to remain with the firm, such as golden parachutes and low- or no-interest loans.

20ReviewStrategy and long-term incentivesFederal lawShort-term incentivesStrategic long-term incentivesOther incentivesCopyright 2013 Pearson EducationChapter 12-21We have discussed the relationship between a firms strategy and an executives long-term and total rewards package. In doing so, we discovered that the executives desires and the needs of the firm are inextricably interwoven.

Federal law such as the Sarbanes-Oxley Act mandate a greater sense of personal responsibility and understanding of the workings of a business to remain successful.

Short-term incentives and annual bonuses consider eligibility, fund size, and individual performance. Some firms use a formula to calculate the proper incentives.

Typical strategic, long-term incentives include stock options, stock plans, and ethical considerations.

Finally, some firms may offer golden parachutes or low- or no-interest loans to top tier executives in order to entice them to stay aboard. 21TheMost Popular Organization-wide Variable Pay PlansCopyright 2013 Pearson EducationChapter 12-22Weve focused to this point on individual employee incentives such as piecework, commissions, and executive bonuses. Lets look now at incentives for teams, and for allemployees company-wide.22Team &Organization-wide Incentive PlansDesigning team incentivesEngineered standardsPros and consHR inequities that undercut team incentivesCopyright 2013 Pearson EducationChapter 12-23There are three approaches to designing team incentives. First, members are paid based on one of three team-based formulas wherein all members receive the pay (a) earned by the highest producer, (b) earned by the lowest producer, or (c) equal to the average pay earned by the group. Second, set a production standard based on the final output of the group as a whole. Finally, tie rewards to goals based on some overall standard of group performance.

A lot of our work today is organized around teams, so team incentives make sense to encourage cooperation and training. But exceptionally hard-working employees do not get paid according to their efforts, which may reduce motivation. Some studies suggest that team incentives are often counterproductive. The fundamental problem was inequity. Unless you actively minimize inequities, its probably best to pay employees based on their individual contributions to the team, rather than on collective team performance.

23Team &Organization-wide Incentive PlansProfit-sharing plansScanlon plansOthergainsharingplansAt-risk pay plansEmployee stock ownership plansCopyright 2013 Pearson EducationChapter 12-24Profit-sharing plans involve employees receiving a share of the companys annual profits.

A Scanlon Plan is an incentive plan developed in 1937 by Joseph Scanlon. The basic features of the plan include: philosophy of cooperation, identity, competence, involvement system, and sharing of benefits formula.

Other gainsharing plans are incentive plans that engage many or all employees in a common effort to achieve a companys productivity objectives.

At-risk pay plans put some portion of the employees weekly pay at risk, subject to the firm meeting its financial goals.

Employee stock ownership plans (ESOP) are company-wide plans in which a firm contributes shares of its own stock (or cash to purchase the stock) to a trust. The trust is established to purchase shares of the firms stock for employees.

24ReviewTeam incentivesInequitiesProfit-sharingScanlon and gainsharingAt-riskESOPsCopyright 2013 Pearson EducationChapter 12-25Since many firms are moving to a team-based environment, we have discussed the need for incentive plans that reward teams. We also discussed issues related to why some team-based programs fail or are counterproductive. The chief issue is to manage any inequities in the systems, real or perceived.

Profit-sharing, Scanlon plans, gainsharing, at-risk pay plans and Employee Stock Ownership Plans (ESOPs) are all ways to recognize and reward employees based on company results. 25The Steps in Designing Effective Incentive PlansCopyright 2013 Pearson EducationChapter 12-2626The Five Building Blocks of Effective Incentive PlansCommon senseLinkagesEffort RewardsStandardsContractMeasurementCopyright 2013 Pearson EducationChapter 12-27Follow these guidelines to make your plan more effective: use common sense; link the incentive with your strategy; make sure effort and rewards are directly related; set effective standards; view the standard as a contract with your employees; and use good measurement systems.

27ReviewCopyright 2013 Pearson EducationChapter 12-28Once again, here are the five areas to address to ensure you are creating an effective incentive plan. Ask: Does it make sense to use incentives?Link the incentive with your strategy.Make sure the program is motivational.Set complete standards.Be scientific.28

All rights reserved. No part of this publication may be reproduced, stored in a retrieval system, or transmitted, in any form or by any means, electronic, mechanical, photocopying, recording, or otherwise, without the prior written permission of the publisher. Printed in the United States of America.Copyright 2013 Pearson EducationChapter 12-29